Question

REPLACEMENT ANALYSIS

The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $280,000. The old machine is being depreciated by $120,000 per year, using the straight-line method.

The new machine has a purchase price of $1,125,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $155,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $240,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.

What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
$  

Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.

Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
1	$	$	$
2
3
4
5

What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.

Year 1	Year 2	Year 3	Year 4	Year 5
$	$	$	$	$

Answer 1

	Old Machine Book Value	$600,000
	No of Useful Life	5 yrs
	Can sell it now at $280000
	Depreciation per year	$120,000
	Purchase price of new machine	1125000
	No of Useful Life	5
	Salvage value	$155,000
	Depreciation rates	20,32,19,12,11,6
	Annual Savings	$240,000
	Tax Rate	35%
	WACC	12%
1	What initial cash outlay is required for the new machine
	Cost of New Machine	-1125000
	Sale of Old machine	280000
	Tax Savings on old machine	112000
	(600000-280000)*35%
	Initial Cash outlay	-733000
2)	Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made.
	Year	Depreciation allowance, New	Depreciation allowance, Old	Change in depreciation
	1	225000	120000	105000
	2	360000	120000	240000
	3	213750	120000	93750
	4	135000	120000	15000
	5	123750	120000	3750
				457500
	Year	1	2	3	4	5	Total
	$	20	32	19	12	11	94
	Dep (1125000*rate)	225000	360000	213750	135000	123750	1057500
		1125000-1057500	67500
3)		Year 1	Year 2	Year 3	Year 4	Year 5
	Savings	240000	240000	240000	240000	240000
	Differential Depreciation	105000	240000	93750	15000	3750
	EBT	135000	0	146250	225000	236250
	Less : Tax @ 40%	54000	0	58500	90000	94500
	EAT	81000	0	87750	135000	141750
	Add: Diff Dep	105000	240000	93750	15000	3750
	Cash flow	186000	240000	181500	150000	145500
	Opearting Cash flow in year 5			145500
	Cash SV of new Machine			155000
	Tax on profit on Sale (155000 - 67500)*0.40			-35000
	Cash Flow			265500
	Year	Cash flow	Incremental cash flow
	Year 1	186000
	Year 2	240000	54000
	Year 3	181500	-58500
	Year 4	150000	-31500
	Year 5	265500	115500